Tuesday, June 28, 2011

Failure to Trickle Down and other Taxing Realities


by Glen Sherman

As we move toward another presidential election season while trying to recover from an economic downturn, enduring debates on raising the debt ceiling, and hearing proposals aimed at severely slashing government budgets, I feel compelled to write a summary of America's approach to taxes and budgets over the last 30 years.

Since we were introduced to Reaganomics in 1980, the concept of cutting taxes on the wealthy and corporations as a method of increasing job growth and stimulating the economy has been by far the dominant political position embraced by most republicans and some democrats. In fact, most Americans under 35 years of age have grown up hearing this single economic approach almost exclusively. It has been known and reinvented using several names such as Trickle Down Economics, Supply Side, Supply Chain, Support for the Job Creators, et cetera. Make no mistake; it is all the same concept. Those who support this economic concept also generally seem to believe that all budget issues must be solved on the spending side, never on the revenue side. Additionally they believe that cutting taxes increases government revenue and that a graduated tax is unfair, compelling high income earners to pay too much. Most also believe that we must preserve the free market with little or no government regulations.

Let's work through the basic premise and these adjacent beliefs. We live in a capitalist society where profit making is encouraged. Even though we have some government regulations, we do enjoy a mostly free market. As most republicans and democrats will agree, along with anyone who has ever taken an economics class, this system is ruled by the law of supply and demand. Prices, market share, and hiring are all ruled by supply and demand. This brings us to the biggest flaw in the concept of Trickle Down Economics and the idea that tax breaks for the wealthy will create jobs. 

Example: If I own a factory with 100 employees who are able to produce enough product to meet demand, why would giving me a tax break make me want to hire more employees? I have the same market share and demand; I am already meeting that demand, and until that demand increases beyond the ability of my current work force, I have no reason to increase that work force no matter how much of a tax break I receive. In fact, each time we cut taxes for the "Job Creators," the gap between the low and high wage earners increases, while the number of people considered middle class decreases. Extra jobs are not created, and the wealthy simply put the extra money in their pockets.

On the subject of how much we should pay in taxes, many feel a graduated scale is unfair. On the surface this would seem correct, but because of many tax shelters, loopholes and the ability to take income in other forms than payroll available to high income earners, the wealthy often pay a lower overall tax rate than lower earners. Corporate CEOs often take alternate compensation in the form of stocks, paid transportation (including use of company cars), or payment of items that would otherwise be their own personal expenses. Wouldn't a person who makes $25,000 per year like the free use of a car, including maintenance and fuel, that many corporate CEOs receive as part of an unclaimed compensation package? These extras often go untaxed; or in the case of stocks, the tax is delayed and comes at a lower rate. When we look at the total compensation, the folks in the highest tax brackets often pay much lower overall tax rates. These high earners often promote the idea of a flat tax as a fair alternative, but when asked if that flat tax rate could be applied to all earnings and compensation they receive, no matter the form, they suddenly don't like the idea. 

Recently, some have promoted eliminating the federal income tax and instituting a VAT (Value Added Tax), or national sales tax as a fair alternative. The problem here is that lower earners don't have extra income they can set aside as savings, but higher earners do. A person who earns $25,000/year spends all of that money on food, housing and other necessary expenses, so if the VAT were 20%, they would pay 20% of their entire income in tax. Another person who earns $25,000,000/year and spends half the income while saving the other half will only pay an effective rate of half the VAT on their total income. It is no wonder that all these so-called fair alternatives are being promoted by high earners who are trying to convince the lower earners that such proposals are a good idea.

What about the idea that cutting taxes increases revenue? The statistic always quoted to support this idea comes from a moment in time during the Reagan administration. I'll explain: Large corporations, especially those that do a great deal of business outside the US, but report income and pay taxes in the US, can often control the timing of their income reporting. A corporate CFO who believes tax laws will change in the corporation's favor can delay fund transfers and therefore delay income reporting until after the tax change and then pay the earnings tax at the new lower rate. 

This was the situation when Reagan was elected, and many corporations and extremely high earners were confident that they would see a tax reduction. This delayed some reporting in the previous year, decreasing the federal revenue and artificially increasing revenue the following year, but at the lower rate. This created the myth that lowering taxes increases revenue, but it was simply delayed revenue, and the total over time was less than if the tax rate stayed the same. This so-called revenue increase wasn't very effective because during Reagan's term we almost tripled the national debt. The economy seemed okay, but we were simply running up the bills with no plan to pay them. 

During the Clinton administration, the upper tax rates were raised despite warnings that it would destroy the economy. Clinton left office with a strong economy and a budget surplus, where we were then warned against the dangers of paying off the national debt too fast. During the Bush II administration, we went back to the Trickle Down concept with tax breaks for the wealthy; the result being more than doubling the national debt and a recession so deep it was second only to the Great Depression.

This leads us to the idea that budgets must always be balanced using the spending side of the ledger and never via the revenue side. In the example above, Clinton recently disproved this idea. In another revenue example from the past, we once had an extremely small but effective tax on stock transfers. This tax was small, but it had multiple benefits. First, it created revenue for the federal government and actually more than fully supported the operations of the SEC, tasked with monitoring stock activity. 

The currently underfunded SEC is hard-pressed to monitor all this activity, and as we have seen in recent years, many traders are willing to take advantage of the lack of supervision. The other advantage to this tax is that when it was in effect, stocks were not traded as wildly as they are today, and the market was less volatile. In the years prior to Reaganomics, when upper tax rates were much higher, not only did we have less trouble with the national debt, but many of the recently slashed government projects to build roads, bridges, et cetera, were fully funded. These projects promote additional economic activity and help build a secure future, creating an upward economic spiral, not the downward spiral we are currently experiencing.

It always surprises me after a natural disaster, or other such occurrence, when people scream for the government to do more. These screamers are usually the ones who have spent years promoting budget cuts, saying the government should do less. The taxes we pay are an investment, not a burden. The only debate should concern the most effective way to use that revenue. The wealthy have plenty of money and don't need tax breaks that will never Trickle Down. 

We need to invest in those on the lowest rung of the economic ladder, helping them to become part of our national economic engine. This would benefit everyone.

No comments:

Post a Comment

I want to hear from you but any comment that advocates violence, illegal activity or that contains advertisements that do not promote activism or awareness, will be deleted.